Bad Folk Economics, 11/24

Be suspicious of the term "supply chain."

Pierre Lemieux writes,

Despite two centuries and a half of economic analysis, supply-chain talk typically ignores the crucial role of prices on the open market. Prices are bid up here and bid down there, continuously adjusting quantity supplied and quantity demanded, reconciling scarce resources and nearly infinite human desires. (See Hayek, “The Use of Knowledge in Society,” American Economic Review, 1945.) Except when government cap prices like during the first year and a half of the pandemic, or when the mob descends in a witch-hunt of “speculators,” “profiteers,” and “price-gougers,” goods keep moving in response to price signals and disruptions don’t last.

If you think that complex production involving many steps, multiple countries, and many different people is a 21st-century phenomenon, I suggest that you consult I, Pencil, an essay by Leonard E. Read written in 1958.

The term “chain” is misleading in at least two ways. First, it suggests something that is designed. As if every retailer has the necessity and the ability to design its supply chain. It has neither.

Second, it suggests that complex, multi-stage production processes are fragile. If one link breaks, the whole chain must break. But in fact, a market economy is more like the Internet. When a Web server sends your computer a packet of information over the Internet, there are many possible routes it could take. If one route is broken or crowded, the packet takes a different route.

Instead of “supply chain,” we should say “roundabout production,” the term preferred by Austrian economists. For example, an automobile is the final product of millions of early steps. Some of these steps involve constructing factories and machinery. Not only to assemble the car, but also to assemble the metals and the computer chips that go into the car.

How does the economy know that chips need to go to car manufacturers, rather than somewhere else? Prices provide the guide. If consumer behavior raises the price of video game players relative to the price of cars, then the price system will direct manufacturers to supply more chips to gaming-device producers and fewer chips to automobile producers.

Unfortunately, there is a lot of bad folk economics out there, much of it coming from credentialed economists. Don’t think about “supply” as some fixed amount and “demand” as some other fixed amount. Instead try to grasp the notion that supply and demand intersect at a market-clearing price.

“Supply chain” is another piece of bad folk economics. Instead, think in terms of roundabout production, guided by the price system.